Applied Rationality focuses on public policy issues and tries to take a liberal perspective that is consistent (comments to the posts will often show otherwise) with neoclassical, rational-choice economics.

Sunday, August 26, 2007

The Social Security clock continues to tick

We haven’t heard much lately from Washington about reforming the Social Security system; however, the problems for the system continue to mount. In their last report in April, the Social Security Board of Trustees projected that we will begin drawing down the Social Security trust fund 10 years from now (in 2017) and that we will exhaust the trust fund 24 years later (in 2041). During the last year, the projected unfunded obligation to pay future retirees over the system’s 75-year planning horizon increased by another $100 billion.

A little background is in order. In 1983, a bipartisan compromise saved the Social Security system. The system had exhausted its trust fund and was paying out more in benefits than it was receiving in revenue. President Reagan, a Republican Senate, and a Democratic House made several fundamental changes to the system. Some of those changes reduced potential obligations of the Social Security System; most importantly, the legislation gradually increased the age at which people qualified for full retirement benefits from 65 to 67. It also delayed cost-of-living increases for six months. Other changes increased funds going into the system; these included raising the FICA tax rate and expanding its coverage to higher earnings levels. As a result of these changes, Social Security once again began taking in more money than it paid out, investing the surplus in U.S. treasury bonds, which would be redeemed after baby-boomers began to retire. In historic terms, the legislation was a stunning success; a program that was insolvent a quarter-century ago was stabilized and will continue operating for many years to come.

There’s a catch, however, and that has to do with the composition trust fund, which consists entirely of U.S. treasury bonds, that is, debt that we as a country owe to ourselves. Thus, the trust fund is a bunch of IOUs. Depending on your view on these things, this isn’t necessarily a bad thing. Some of the bonds have gone to pay for things like schools, children’s health care, infrastructure, and research that should make the country more prosperous in the long-run and increase its ability to pay. The bottom line, however, is that recovering money from the trust fund does depend on the ability of the U.S. to make good on these debts, while taking care of its other obligations.

Starting in about 2017, a portion of payments to retirees will start to come from these extra payments. To get some idea of the extra pressure on our budget, consider that the federal deficit this year is somewhere in the neighborhood of $160 billion—better than the last couple of years but still unacceptably high for the late stages of an economic expansion. But this figure includes the net contributions to the Social Security trust funds, which are taking in about $190 billion more than they are paying out this year. In the absence of these contributions, the deficit would be more than twice as high as it is right now. Over the next ten years, these extra contributions will fall to zero. To put it one way, there will be an extra $190 billion of pressure on the budget in a decade, and even greater demands after that.